New bookbuilding rules for equity and debt capital market deals by the Hong Kong’s Securities and Futures Commission came into force on August 5. Nearly two months on, the sweeping norms appear a bit toothless.
In the absence of any meaningful deal flow since early August, it may be hard to test the effectiveness of the rules, but a consensus has rapidly emerged among market participants — the regime has added to the workload, but made little impact on the pain points they were supposed to tackle.
Transparency in the bookbuilding process is at the heart of the SFC’s changes. The norms ban so-called X-orders — the practice of inflating books with anonymous investors — and have brought in measures to improve investor confidence and introduce a fair price discovery process.
The rules require bookrunners to identify the bond investors to the issuer and appoint an overall coordinator to handle the deal; the latter requirement is more critical for Hong Kong IPOs. The SFC is additionally discouraging proprietary orders, or bids that are placed by different entities under the same parent.
The regulator’s intent is good: improve transparency in the bookbuilding process and boost standards in the market.
But the opposite seems to have happened, moving the Hong Kong capital markets further away from international best practises.
In its bid to clarify the situation, the SFC has proactively released a lot of FAQs since wrapping up an initial consultation on the matter last year and then releasing the rules. But the details are now biting investment banks operating in the industry.
For instance, GlobalCapital Asia understands X-orders can still find their way into deals by being placed on an “omnibus” basis.
What this means is that even though the norms require the identity of the investors to be disclosed, this requirement is substantially diluted for mixed syndicates that consist of bookrunners from Hong Kong and overseas.
In such situations, the pool of orders, or the omnibus, does not require detailed identification of the end investors. This loophole benefits private banks that demand anonymity and bookrunners that have long placed orders using multiple entities of the same group.
Fee and mandate letters are other areas where misuse is emerging.
SFC’s rules were expected to end the era of zero fees, curbing unhealthy competition between bookrunners. The new rules urge the fee details to be broken down into a fixed and a variable portion to retain the somewhat controversial norm of rewarding bookrunners that bring in more orders.
But issuers have found a loophole. They are pushing the full bookrunning fee under the variable component and retaining zero fees for the fixed portion. This gives firms the discretion to award banks based on their role in deals and the amount of orders they bring in.
Some companies are also reluctant to issue official mandate letters, so they can sneak in bookrunners into a deal at the last minute. This usually happens when banks not on the deal originally are able to bring in orders for the transaction, effectively clinching a role on the trade.
On its part, the SFC has been pragmatic in giving leeway to bookrunners so that the rules do not end up strangling them.
Bookrunners have been urged to show “reasonable efforts” were made to obtain mandate letters or negotiate a fee. Such a concession is needed, but it can also make situations more murky.
Another issue has also only been partially addressed. The rules encourage bookrunners to de-prioritize orders placed by a single group. Chinese deals, for instance, are traditionally backed by bookrunners with several group entities placing orders. This practice displaces genuine investors from getting their due share of allocations, while impeding a market-driven price discovery process.
The rules now allow the de-prioritisation but only if the issuers choose to waive it.
Great expectations
It can be argued that market expectations from the SFC rules were already displaced to begin with.
Technically, the SFC has jurisdiction only on entities based in Hong Kong; players from Mainland China and the rest of Asia are outside its purview.
Another fundamental problem with the rules is that it seeks to govern the behaviour of bookrunners and not the issuers. In volatile times like now, issuers should also be held equally accountable to use best market standards.
The SFC is aware of the limitations of its rules and that of the bookrunners. But in its attempt to usher in better bookbuilding practices, it has ended up making processes more cumbersome, less transparent and out of line with global market standards.
Given the fragmented nature of the Asian bond market and the multiple jurisdictions in the region, the SFC could take a more collaborative approach by engaging with regional regulators to align rules — if only in spirit.
The rules, despite the many loopholes available, offer the regulator an opportunity to exercise its enforcement rights, too. Without being too heavy-handed, the authority could tighten its own audit processes and hold firms defying the rules accountable.
No regulator likes rolling back previously unveiled rules and guidelines. But the SFC still has an opportunity to tweak the rules in line with real-time market feedback. Prioritizing straightforward market features like preventing conflicts of interest and boosting transparency will move the needle a lot more than focusing on the minutiae of its regime.
Bodies like the International Capital Market Association can also be a bigger force by serving as the voice of market participants. Issuers and law firms, too, have responsibility to adhere to high quality standards on deals.
The extent of the damage from the new rules will only become clearer as deal flow resumes in the region. But if the concerns raised by the market are anything to go by, the rules have missed the mark.